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VQT and PHDG are exchange traded products based on the S&P 500 Dynamic VEQTOR Index.

The S&P 500® Dynamic VEQTOR Index dynamically allocates long-only exposure between the S&P 500, the S&P VIX Short-Term Futures Index, and cash in order to measure broad equity market exposure with an implied volatility hedge. The index mitigates risk between equity and volatility and helps hedge downside protection in volatile markets.

(source: spindices.com)

Capital allocation is calculated daily between S&P 500 stocks and futures, VIX short-term futures, and cash. In a previous article (read here) I have made a presentation of the index, the products, and their respective behavior since their inception dates.

My conclusion was that PHDG and VQT lag SPY in bull markets, but still have positive returns. In market downturns and higher volatility, their hedging power is more or less equivalent to a short position in SPY (or a long position in SH).

A reader asked if it was possible to use VQT or PHDG to replace SPY for a safer stock market exposure. Here is my answer.

The first chart shows the equity curves of VQT (in red) and SPY (in blue) since 1/1/2011.

(click to enlarge)

PHDG and VQT have similar behaviors and a low tracking error. I use VQT in simulations because of its inception date (August 2010 vs. December 2012 for PHDG), but my preference goes to PHDG because it is an ETF and its holdings are published on a daily basis. VQT is an ETN (Exchange Traded Note). PHDG has also lower management fees (0.39% vs. 0.95% for VQT).

The red line of the second chart is the equity curve of an equal weight portfolio of SPY and VQT, rebalanced weekly. The blue line is SPY again.

(click to enlarge)

The next table details the performances of both charts.

Total Return (%)

Annualized (%)

Drawdown (%)

Sortino

Standard Dev (%)

SPY

47.0

14.7

-20.2

0.84

19.5

VQT

29.6

9.6

-14.6

0.55

16.9

VQT+SPY

39

12.4

-11.2

0.93

14.5

Looking at the numbers, it is obvious that VQT and PHDG should not be used as a lower-risk replacement for an S&P 500 equity fund. The weekly risk-adjusted return of VQT (Sortino ratio) is much lower than for SPY.

The good news is that the equal-weight portfolio VQT+SPY has not only a better Sortino ratio, but also a much lower maximum drawdown than each of its components. It makes VQT and PHDG good "buy-and-hold" tickers to hedge stock positions. The equal weight portfolio VQT+SPY has a lower return than SPY, but if you leverage it by a reasonable 1.25 factor, you get a similar return for a lower risk (standard deviation) and a much lower drawdown. The next table takes into account A 2% rate for margin costs and 0.1% for transaction costs at rebalancing.

Tot. Ret. (%)

Annual. (%)

Drawdown (%)

Sortino

Std Dev (%)

SPY

47.0

14.7

-20.2

0.84

19.5

(VQT+SPY) x 1.25

48.1

15.0

-14.0

0.93

18.1

Of course, these statistics don't cover all market conditions. This is a bullish period, with a big correction and a few smaller ones. In fact, numbers would be more favorable to VQT and PHDG in a bear market. If we look at the past as far as stock data exist, bull markets have been longer than bear markets on average. A hedging strategy should be first focused at not being a heavy drag when the winds are favorable for stocks. Improving the risk adjusted return of a stock portfolio even in a bull market, VQT and PHDG look good candidates to do the job. I use PHDG to hedge a part of my quantitative portfolio (more info here).

Source: Are VQT And PHDG Investments Or Hedging Tools?